When you get multiple lenders to provide a loan quote, why the heck would you choose the one with the higher interest rate. Well, there are a few reasons.
You know what? Interest rates are low.
Commercial real estate investors across the country are refinancing their assets to take advantage of a central banking system that can’t drop benchmark rates any further without going negative.
But rate is far from the only relevant number when it comes to evaluating a commercial loan quote. Here are seven solid reasons why a borrower may choose a lender that doesn’t have the lowest rate around.
We’ve written about this one before, but the quick synopsis is this: a longer amortization period on a loan results in lower loan payments, and more cash flow for the borrower.
If you are shooting for higher investment returns, you should key in on the Loan Constant, rather than just looking at the Interest Rate for different loan quotes. A favorable loan constant means that the higher the leverage, the higher the returns. If you are tight on cash to use as equity, a higher loan amount might be the right decision (or the only decision) to make for your deal even if the loan constant is negative.
Just like longer amortization schedules reduce how much principal is paid back on the loan in a given time period, interest-only periods entirely pause principal payments. This allows two things to happen:
“Permanent” commercial mortgage loans can typically hold a 5, 7, or 10 year fixed rate before resetting or requiring the borrower to refinance completely. Locking in a low fixed rate for a longer period of time is attractive to many borrowers, even if it’s not the absolute minimum rate.
On the other hand, a shorter loan term may better match the business plan for heavy value-add assets. If you believe you can increase income and force appreciation for your asset over a 1–2 year period, it could be worth paying up a higher interest rate during that time if the lender offers other benefits.
Another degree of flexibility is a softer prepayment penalty, which keeps the option to sell or refinance viable over the life of a loan. Some types of loans, like CMBS, are inherently difficult to pay back early. Among financial institutions, there are many different flavors of prepayment penalties, from Yield Maintenance down to no penalty at all.
Personal liability is something that, all else equal, a borrower would like to avoid. Even when it’s not all equal, borrowers may want or need to seek a non-recourse loan, or prefer to limit the recourse provisions. This is absolutely a reason why a borrower may take a loan at a higher rate.
Time is money, right? Acquisition deals often come with a defined due diligence period, and a required closing date. Missing that date has consequences. Similarly with refinancings, a borrower does not want to go into default on a previous loan while waiting for a lender to complete their underwriting and issue an approval. A lender that can close more quickly can charge a premium interest rate (on certain transactions).
Interest aside, the fees on a commercial mortgage can be heavy. Keeping money in your pocket as a borrower must take fees into account. 2% origination at 8% interest is seldom more attractive than 1% origination at 9% interest — it’s a time value of money thing.
Finally, these decisions are made by humans, not machines. If a borrower knows, likes, and trusts a specific lender, or if they are persuaded to trust in a lender by a given Capital Advisor they trust, it goes a long way in the borrower’s decision-making process.